Inflation Flashcards
Inflation
sustained rise in the general price level.
Effect of rise in VAT on inflation
A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm’s production costs.
Effect of exchange rate on inflation
Currency depreciation leads to lowering price of exports, increase in quantity of exports, increase in price of imports, decrease in quantity of imports. Therefore there is higher net exports and higher aggregate demand - demand-pull inflation. Also, the cost of imported raw materials increase, cost of production increases, and aggregate supply decreases leading to cost-push inflation.
Demand-pull inflation
Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap. When there is excess demand, producers can raise their prices and achieve bigger profit margins
Causes of Demand-pull inflation
- Depreciation of the exchange rate
- Higher demand from a fiscal stimulus
- Monetary stimulus to the economy
- Fast growth in other countries
Effect of Higher demand from a fiscal stimulus on inflation
Demand-pull. e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow
Effect of Monetary stimulus to the economy on inflation
Demand-pull. A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods” and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.
Effect of Fast growth in other countries on inflation
Demand-pull. providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK
Cost-push inflation
Cost-push inflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins.
Causes of Cost-push Inflation
- raw material costs
- Rising labour costs
- Expectations of Inflation
- Higher Indirect Taxes
- A fall in the exchange rate
- Monopoly employers/profit-push inflation
Effect of Component Costs (raw material) in other countries on inflation
Cost-push. e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.
Effect of Rising labour costs in other countries on inflation
Cost-push. caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation
Negative consequences of Deflation
- wages may fall
- discourage consumption
- real interest rate rises
- less revenue for business, unemployment tend to rise
Positive consequences of Deflation
- improved international competitivness
- rising real income
- lower costs of living
